Saturday, January 24, 2009


. Saturday, January 24, 2009

Lots of talk of currency fluctuations lately. Sure, there's the U.S./China spat over the RMB, but the controversies hardly end there:

Russia announced that the rouble, down 30 per cent since July, will be allowed to drop another 10 per cent against the dollar. Then it will try to bring the devaluation to an end.

The fall in sterling, which has halved in yen terms in the past 18 months, brought complaints from European politicians that the undervalued pound was an unfair advantage for the UK over the eurozone.

As for Japan, the 35 per cent fall in its exports last month was doubtless worsened by the 39 per cent rise in the yen against the dollar over the past 18 months, bringing it to a 14-year high. With western economies booming, Japan’s exporters could survive a strong yen. That is no longer the case. Asked on intervention, Japan’s finance ministry said it “should always be thinking about doing what may be necessary”.

What of China? The exchange rate of the renminbi to the dollar has barely budged since its appreciation halted last July. Amid market chaos, this was achieved only with careful management or, pejoratively, manipulation. But according to JPMorgan Chase, it has gained 12 per cent on a trade-weighted basis in the past year.

Nouriel Roubini was one of the only economists to predict an unraveling of the global financial infrastructure. But he predicted that it would occur because of a collapse in the value of the dollar; not because of over-leveraging and dodgy home loans. Indeed, the U.S. could use a decline in the dollar to boost employment in exporting sectors and try to narrow the trade imbalance. But that hasn't happened. Instead, as the financial crisis has spread, smaller countries have flocked to the dollar (and euro) as a source of safety. Countries who rely on exports to boost growth -- like Russia and China -- have tried to keep the value of their currencies low to make their exports cheaper. Meanwhile, the pound is losing a lot of value, which is starting to really bother other European countries who feel that a cheap currency gives Britain an unfair competitive advantage in trade, and Japan has still not recovered from its zombie decade.

What does it all mean? It's possible that currency fluctuations will lead to beggar-thy-neighbor protectionist measures. It's also possible that the U.S. and Eurozone carry greater weight of unemployment and reduced GDP in the short- to medium-run by letting smaller countries ramp up their export-machines. It's also possible that domestic stimulus plans in the U.S. and Europe will simply be an employment subsidy to China and other less-developed export-heavy countries. That might not be the worst thing in the world, except that it prolongs the needed structural adjustments. It might be better for countries to coordinate large fiscal stimulus, and impose some levels of capital controls (a Tobin Tax?) to slow down currency fluctuations and avoid a crisis. We should also expand the role and capabilities of the IMF, just in case it becomes necessary to bailout a fairly large country (e.g. Great Britain?).

What we should not do is start a cycle of devaluation competition or protection for domestic import-competing sectors of the economy. If that occurs, look for nations to call for bounded exchange rate pegs.






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